I don't trade stock pairs during earnings, I like etf pairs for the reasons you listed, as well as pairs 2 securities of the same company, adr's, common vs b shares etc.
pair trading is probably the safest method to protect against a black swan event. Remember both stocks may go down, but the weaker stock should go down more. You may incrue losses but they will be less than if you didn't have a pair on. With pairs I don't like to use stops. I usually won't close out a pair unless something fundamentally has changed to change the order of the pair.
the way I see it.....it's foolish not to add another layer when the pair goes out of the money. but this is why people get blown up. so add layers not every 1 stddev but 2 or 3...... and do just 1 or 2 layers......this greatly increases ur w/l ratio. without adding layers, your chances of winning isn't very good. best thing about pairtrading is its high probability of winning. and to exclude the option to add layers, or to NEVER do layers is not the solution. How often do you guys get in the money right away anyways......... Only protection against the overnite news/takeover is try not to short the smaller companies. let smaller stocks be the long leg and bigcaps the short let. should research which stocks are good takeover candidates and avoid using pairs on these stocks.
I closed my ugly POT/CF trade today for a profit! Still I will be adhering to my new rules with trades like that. Sold POT @ 162.05 Covered CF @ 131.20 Couldn't find any new trades today that fit my criteria, I will work on expanding my universe this weekend. Open trades: 12 Wins: 6 Losses: 0 Have a good weekend everyone.
By "adding layers" I assume you mean you average down on the position? If so then I assume you do this because your entries are usually not that great?
Trading pairs it's actually very easy to calculate the potential loss exposure for X amount of layers...you really have to understand their ranges, everything from the 5 day to the 2 yr and how the trend. I'm actually in the process of increasing my position sizes this w/e. I know how much heat I can expect to take from each position for X amount of move and what that represents of my account. I allocate a maximum of 3-4 layers but as i mentioned before these are never layered arithmetically, i vary the size all the time which is a big factor in my consistency.
I had a huge PNL turnaround today as i was fighting my CF pair and actually went extra long 40% CF yesterday near the lows when the stock was so battered. That's what I like about pairs is that there are many different techniques and skills you develop to increase profitability.
Yes and no..... when you initiate a position in pairs.....that's because you find variance in 2 highly correlated stocks. for instance, you find ABX up 2 bucks and GG down 1. this is very unusual and upon confirming that this crosses 2 std dev, u go long GG and short ABX. This entry cannot be great initially b/c you're expecting not 1 but 2 stocks to reverse pattern. so in most cases like this I find myself out of money at least for few minutes. and for traders like johnnysharp and yobo here, who swings for days, it's not uncommon for the position to be out of money for days. that's why this strategy, although high chance of winning, requires alot of patience. johnny, thx for the excellent thread, I'm really enjoying all the comments here. Could it be possible for you to post the actual winning spread? for instance on your last trade POT/CF pair............post something like +1.35 .....don't need the $ amount. good luck